Volume 10, Number 1

Jan u ary 2004

F E D E R A L R E S E RV E B A N K O F N E W Y O R K

Current Issues
w w w. n e w y o r k f e d . o r g / r e s e a r c h / c u r r e n t _ i s s u e s

IN ECONOMICS AND FINANCE

Why Were Banks Better Off in the 2001 Recession?
Til Schuermann
In a sharp turnaround from their fortunes in the 1990-91 recession, banks came through the 2001 recession reasonably well. A look at industry and economy-wide developments in the intervening years suggests that banks fared better largely because of more effective risk management. In addition, they benefited from a decline in short-term interest rates and the relative mildness of the 2001 downturn.
he 1990-91 recession weighed heavily on banks. As the institutions entered the downturn, they were still recovering from the Latin American debt crisis of the mid-1980s, and they faced new difficulties with the declining quality of their real estate loans. Low profits, poor capitalization, and a high incidence of nonperforming loans during this period made it especially hard for banks to weather the economic setbacks and continue lending. In the 2001 recession, by contrast, banks were in a much stronger position. Profits were among the highest in the past thirty years (Chart 1), and capitalization and loan quality were more robust than in 1990-91.1

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bank managers. Nevertheless, good fortune also played a role by creating a more favorable banking environment. Although we cannot test the relative importance of skill and luck directly, we look at a range of suggestive evidence. To analyze the effect of skill on bank performance, we consider two key tools of bank managers: risk management and the strategic pursuit of new markets and new sources of revenue. We present evidence that banks are now managing their risks more effectively by adopting risk-based pricing in several markets. As a result, the institutions are providing broader access to credit while being compensated for the additional risk they are assuming. We also show that banks today are using credit derivatives to shift some portion of their credit exposure to insurers and asset managers. The effectiveness of the second tool used by bank managers—the pursuit of new markets and new revenue sources—is less clear. Gains from geographic diversification have become harder for certain banks to realize over the years, and some preliminary research (Stiroh forthcoming a) suggests that risk-adjusted returns from revenue diversification have not been forthcoming.2

This edition of Current Issues examines why banks fared better in the most recent recession. Specifically, we consider how much of their success stems from skill on the part of bank managers and how much stems from simple luck. Banks play a vital role in the economy, matching the supply of capital with demand, so knowing how a downturn affects these organizations is important to understanding business cycle dynamics. We find that banks’ improved performance in the 2001 recession is attributable in large part to the skill shown by

these reasons cannot fully account for the difference in pricing between corporate bond and syndicated loans. retail.5 1. tend to be more heterogeneous.3 0 1966 Return on assets Scale Return on equity Scale Percent 15 12 9 6 3 0 70 75 80 85 90 95 00 02 Broadly. Syndicated loans. the menu-price of a spread above.CURRENT ISSUES IN ECONOMICS AND FINANCE VOLUME 10. The evidence that luck contributed to the strong performance of banks in 2001 rests on two developments. the Treasury rate often does not capture all of the relevant aspects that govern a contractual lender-debtor agreement. More specifically.which in turn can lead to more efficient risk sharing and capital allocation. by contrast. it seems appropriate to use this bond index. market risk models became part of the regulatory process. with standard covenants. proposed revisons to the Basel Accord have been designed to align regulatory capital more closely with the underlying risks by encouraging more systematic risk management practices. Such an environment enabled the institutions to borrow at a lower cost.6 There are several reasons for this phenomenon. contracts. banks benefited from an environment of rapidly declining short-term interest rates. For loan spreads. the stock market crash. the use of risk management tools and techniques can lead to better risk-based pricing. In addition. say. we compare by credit rating (our measure of risk) the spreads paid on syndicated loans with those paid on bonds in the first quarter of each recession. and features.4 Federal Reserve Chairman Alan Greenspan recently affirmed the value of these initiatives: “The use of a growing array of derivatives and the related application of more sophisticated methods for measuring and managing risk are key factors underpinning the enhanced resilience of our largest financial intermediaries. Second. Specifically. For one.6 0. a degree of flexibility that is especially valuable when a borrower is in distress. we use the above-Treasury spreads of the Merrill Lynch one-to-three-year corporate bond index. 1990:3 and 2001:1 (Chart 2). The Case for Skill: Risk Management Risk management emerged as a distinct banking discipline in the 1990s.9 0. 2 . 1966-2002 Percent 1. which in turn increased their interest margins for a time when they made loans. and the banking industry saw a dramatic increase in the volume and variety of derivative instruments.We also consider banks’ use of credit derivatives as a risk mitigation instrument. These control rights are an option that has value to banks. all things—such as borrower risk characteristics—being equal. With a 1996 amendment to the Basel Accord. for bond spreads. Source: Federal Deposit Insurance Corporation (FDIC).2 0.”5 By comparing the difference in spreads for the 1990-91 and 2001 recessions. enabling them to offer a lower price on loans than the price offered on bonds. NUMBER 1 Chart 1 Returns of All FDIC-Insured Commercial Banks.we use data for the all-in spread for loans rated either by Moody’s or by Standard & Poor’s. and the onset of turmoil in real estate lending. In addition. bank lending relationships give banks greater control rights over the borrowing firm. to assess the effect of skill on bank performance. Our findings suggest that banks have improved their performance between the 1990-91 and 2001 downturns in large part by integrating risk management tools in their operations more skillfully. Risk-Based Pricing in Syndicated Lending One can argue that risk in the syndicated loan market— where bank loans to large corporations are syndicated out to multiple lenders—is not priced as accurately as it is in the corporate bond market. both beyond the control of bank managers. First. The syndicated lending data are provided by Loan Pricing Corporation. we examine how the institutions have used risk-based pricing in the syndicated. Accordingly.3 New tools and techniques to manage market risk and credit risk were developed. Historical Statistics on Banking. following the Latin American debt crisis. effective risk management has the potential to increase the stability of the economy. corporate bonds are fairly homogeneous instruments. and small-business lending markets. we can determine if risk-based pricing has penetrated the market more systematically over the 1990s. Thus. Still. Because most loans and commitments have relatively short-term (less than one year) or medium-term (three to five years) maturities. and consequently may be subject to pricing complications that do not arise with corporate bonds. Note: Shaded areas indicate periods designated national recessions by the National Bureau of Economic Research. the 2001 recession—measured by its effect on most major components of GDP—was less severe than both the 1990-91 recession and the average postwar recession.

it is not so much the absolute change in the pricing schedule that matters. Only recently. Thus. banks have consistently made positive earnings announcements for their retail operations in general and their retail lending in particular (Rieker 2002). however. The institutions thus entered the 2001 downturn demonstrating greater risk sensitivity in their retail loan pricing. Merrill Lynch (bond spreads). loan prices appear to have steepened a little. the loan pricing schedule was only 19 percent as steep as the bond pricing schedule. while by 2001:1.10 Banks were indeed making more loans to riskier borrowers. It depends on the risk appetite of investors active in the market at a point in time.072. credit risk is the chief type of risk they face. A similar pattern emerges in small-business lending. rising from 1. but the relative change.” By factoring this score into their risk pricing. issuers computed from 1981-2002 ratings data from Standard & Poor’s. Despite these trends. as well as the average annual default rate for U.45 percent in 2001:1. 1981-2002 Sources: Author’s calculations. we define a credit slope much as one might define a yield curve slope: the mean credit spread of B-rated less A-rated debt. value-weighted (Table 1).” After 1995.Chart 2 Table 1 Relationship between Default Rates and Bond and Loan Spreads Basis points 1.6 233. concludes that 1995 was also a watershed in this market.We note that the relative price of risk—the premium for. Merrill Lynch. Loan spread 1990:3 Loan spread 2001:1 Bond spread 1990:3 Bond spread 2001:1 Defining a Credit Slope Mean Credit Spread of B-Rated less A-Rated Debt. banks’ pricing schedules steepened. suggesting that banks are doing a better job of incorporating risk in their pricing schedules. Loan Pricing Corporation (loan spreads). the pricing schedule in the syndicated loan market was about one-third more risk-sensitive in the 2001 recession than in the previous downturn.12 percent in 2002:1.11 The credit score resulted in more differentiated interest rates (a steeper pricing curve) and made possible more lending to “marginal applicants.9 These earnings results. n e w y o r k f e d . Indeed. while bond prices. Thus. rose to 4.83 percent in 1990:3 to 2. however. suggest that banks are being properly compensated for the additional risk they are assuming. Next. with a peak of 4. banks’ performance in consumer lending might seem poor. and hit a high of 8.84 percent in 2001:1. hence. The year saw the emergence and rapid adoption of a small-business credit score. they have likely been managing risk more effectively between the past two recessions. Berger (forthcoming). analogous to the credit scores used in consumer lending. Risk-Based Pricing in Retail and Small-Business Lending At first glance.200 1. Value-Weighted Loan Slope (Basis Points) 206. banks were compensated for the risk they assumed while expanding their extension of credit.84 percent in 2002:1. credit card rates were relatively undifferentiated. especially when it comes to their credit card operations.7 However. This appears to be the case. the consumer net charge-off ratio—net charge-offs as a percentage of average loans— was higher in the 2001 recession than it had been in the pre- w w w. have risk management tools been designed specifically for this kind of risk. say. in light of the high net charge-off ratios. We see that the pricing schedule is indeed flatter in the syndicated loan market: loan spreads do not follow default rates as closely as bond spreads do. with banks typically posting just one “house rate. This relative price of risk is assumed to be reflected in the bond market. especially for first and second mortgages and credit cards. vious one. The literature on consumer and small-business lending views 1995 as a turning point. for the past six to eight quarters. using data from Standard & Poor’s (default rates).6 883. Risk Mitigation through Credit Derivatives Because banks make loans. Although Chart 2 displays the pricing schedule for loans and bonds in the two quarters. o r g / r e s e a r c h / c u r r e n t _ i s s u e s 3 . have flattened.56 percent in 1990:3. If we narrow our focus to credit card lending. but at higher interest rates.8 In 1990:3.0 Bond Slope (Basis Points) 1.0 Loan-to-Bond Slope (Percent) 19 26 Quarter 1990:3 2001:1 Sources: Loan Pricing Corporation. curiously. for one.S. Edelberg (2003) notes that before 1995. the picture is even starker: the ratio was 3. This risk mitigation trend likewise continued into the 2001 downturn. A-rated as opposed to B-rated debt—need not always be the same. it had become 26 percent as steep—for a total increase of 37 percent.000 800 600 400 200 0 AA A BBB BB B Default rate by rating.

commercial banks and securities firms together transferred out about $350 billion of credit assets. We would also expect other financial institutions that assume relatively little credit risk as part of their operations—such as asset managers. Geographic diversification may shrink risk as banks broaden their exposure beyond just a few state economies. The credit derivatives market has enjoyed extraordinary growth over the past five to six years. Loan-to-asset ratios have increased as banks have expanded geographically. In addition. so the returns must be sufficient to compensate banks for that risk. diversification of revenue sources does not appear to be contributing in a meaningful way to bank performance. The authors contend that there is no evidence. especially mono-line insurers12 and reinsurers. bring new risks. are the largest net sellers of credit insurance. however. The survey findings suggest that there has been a net outflow of credit risk from banks to insurers and asset managers.CURRENT ISSUES IN ECONOMICS AND FINANCE VOLUME 10. Fitch Ratings (2003) broadly confirms these results. most can be thought of as credit insurance: when a bank buys such a derivative. Chart 3 Buyers and Sellers of Credit Derivatives.14 The authors develop an index showing that this phenomenon was particularly pronounced for large banks: the geographic diversification of banks with more than $50 billion in assets increased by 74 percent from 1994 to 2001. another party takes on the credit risk of the loan or set of loans for a fee. The most recent biannual survey by the British Bankers’ Association (2002) reports that the notional volume of these instruments worldwide increased from $180 billion in 1997 to $1. In 2001. The chart presents the shares of credit protection bought and sold in the credit derivatives market by type of financial institution. The British Bankers’ Association survey (2002) confirms these expectations (Chart 3). however. Despite greater geographic diversification among larger banks. the risk-adjusted return—the return divided by the volatility of the return—is also critical. Note: The data exclude asset swaps. commercial banks are net exporters of credit risk abroad. Because of the nature of credit risk. New ventures. Overall. the agency also reports that U. that diversification has led to better loan 4 . we find only some evidence that strategic management efforts have improved bank performance between the past two recessions. By seeking new business opportunities.13 The Case for Skill: Strategic Management Entry into new markets and the pursuit of untapped revenue sources—two forms of strategic management—represent a second tool through which skill might shape bank performance. either in the form of insurance companies or mutual or pension funds—to be net sellers of protection (net buyers of credit risk). although on a smaller scale. Geographic Diversification The Riegle-Neal Act of 1994.95 trillion in 2002. Morgan and Samolyk (2003) find that the average number of markets in which banks took deposits through branches grew by 22 percent from 1994 to 2001. Morgan and Samolyk find evidence that diversification has increased lending capacity. Accordingly.S. factors such as higher correlations between state-level business cycles are making bank gains from such diversification harder to attain. while insurers assumed more than $500 billion. and that banks have taken advantage of it. By the standard of risk-adjusted returns. we would expect banks to be net buyers of protection (net sellers of credit risk). banks aim to increase revenues and returns. while revenue diversification may actually increase risk as managers engage in less familiar business activities. by relaxing interstate branching restrictions. In this way. the bank purchases credit protection and trims its credit risk. has enabled banks to widen their geographic reach. 2001 Market share (percent) 60 Protection bought 50 40 30 20 10 0 Banks Securities Insurers Mono-line Mutual/ firms insurers/ pension reinsurers funds Hedge Corporations funds Protection sold Source: British Bankers’ Association (2002). returns and risk cannot be considered independently in evaluating the success of strategic management efforts. It reveals that banks are indeed the biggest participants as well as the largest net buyers of credit protection. Mutual and pension funds are also net sellers. it appears that banks in recent years have been relying increasingly on credit derivatives to manage their credit risk more effectively. The chart also shows that insurance companies. NUMBER 1 these sometimes complex “credit derivatives” take many forms.

21 percent. consistent with Morgan. we cannot directly evaluate bank income from specific regions. and fees—has been rising steadily. although overall fluctuations are lower. Specifically. the Gramm-LeachBliley Act of 1999 helped pave the way for banks to diversify their revenue sources. Department of Commerce.73 58. from Stiroh and Rumble (2003).3 percent in 1980 to 41. Table 3 Components and Volatility of Banks’ Noninterest Income Sources. Once we control for time and state effects—where the time effect can be viewed as absorbing a national trend in personal income growth volatility—we find that residual volatility (that is. state economies seem to be moving more in tandem. trading revenue. risk-adjusted returns on equity fell as the share of noninterest income rose. they faced an uphill battle in the 1990s.5 29. they are becoming more alike. from about 20. as Stiroh (forthcoming a) and Stiroh and Rumble (2003) show.17 From 1997:1 to 2002:4.S. Thus. Unfortunately.0 Change -17 24 -26 73 84 those calculations—the proportion of variance explained by the time and state effects—increases by 73 percent.Most of the variation is absorbed by just the time (or “national”) effect. Revenue Diversification By relaxing business activity constraints. It shows that the average quarterly volatility of personal income growth decreased from 1.580. the R2 of However. at least in terms of personal income growth.98 percent in the ten years before 2001:1. the share of banks’ income from noninterest sources—such as service charges. or risk.18 A heightened emphasis on the crossselling of products and services to existing customers. 1997:1-2002:4 Percent Source Share of Total Noninterest Income Service charges 14 Fiduciary income 14 Trading revenue 8 Fees and other income 64 Volatility (Annual) 28 34 269 54 Source: Federal Reserve FR Y-9C Reports.2001:1 0.if bank income streams from two different regions are relatively uncorrelated.98 percent to 0.4 1990:4. w w w. and Strahan (2003). if a bank operates in a region with high income volatility and adds business from a low-volatility region. is down. this revenue has migrated into highvolatility services. Overall. offsetting the diversification benefits that banks realized from the weak correlation between different income sources. which increased bank exposure to the economic setbacks of these customers.9 percent in 2002 (Stiroh forthcoming a). from 37 percent to 46 percent.335 to 0. Rime.294 to 0.15 We measure changes in correlation and volatility between the two most recent recessions and infer what the changes signify for the benefits of diversification. our findings suggest that if the goal of banks in expanding geographically is to diversify across state-level business cycles. overall income volatility should decline.18 37 0. o r g / r e s e a r c h / c u r r e n t _ i s s u e s 5 . then one region’s poor performance will be partly offset by the other’s good performance. fiduciary income.Table 2 Personal Income Growth Volatility Prior to the Two Most Recent Recessions Percent Category Average volatility (quarterly) Average correlation Residual volatility (time and state effects) R2 (time and state effects) R2 (time effects) 1981:1. This result suggests that economic volatility. the annual volatility of banks’ net interest income. state-specific shocks) declines by 26 percent. Similarly.73 percent (Table 2). Overall. from 0. Indeed.98 46 0. from 0. n e w y o r k f e d .540. Yet the table also shows that the average correlation in income growth volatility between states has risen over time. these studies find that for the typical bank. This last conclusion raises a key question: Why hasn’t diversification brought gains for banks? In order for banks to realize gains from diversification. is a possible explanation for this occurrence.16 The macroeconomic setting in which banks’ diversification strategies are executed has made success harder to achieve as state economies become more correlated with one another. Source: U.18 percent in the ten years preceding 1990:3 to 0. performance or better returns on assets or equity.98 33.1990:3 1.0 54. Table 2 presents personal income volatility over the tenyear period prior to the first quarter of the past two recessions: 1981:1 to 1990:3 and 1990:4 to 2001:1. so we proxy by using state-level personal income growth. where the R2 increases by 84 percent. we find that while state business cycles are getting smaller. from 0. For example. Bureau of Economic Analysis. Therefore. was lower than the volatility of any component of their noninterest income (Table 3). diversification across regions has to be matched by diversification in economic returns. In addition. the extent to which geographic diversification translates into gains depends on two factors: correlation and volatility in bank income streams.

too. Note: Data are indexed to peak quarters designated by the National Bureau of Economic Research. In the 2001 recession. the yield curve steepened early and quickly. Although all major components of GDP did not experience a mild recession in 2001. benefiting banks. a drop in short-term rates and the consequent steepening of the yield curve enable banks to increase their interest margins for a time by reducing borrowing costs. Moreover.75 percent to 9. can be costly. more robust balance sheets. Bureau of Economic Analysis. although luck was a contributing factor. First. appear thus far to be negligible. Bank capitalization—equity capital as a percentage of total assets—rose from 6.16 percent. that bank balance sheets during the 2001 downturn were not weakened by a deterioration in commercial real estate loans. We note. Simply put.21 Conclusion Banks entered the 2001 downturn with better profitability. bank profitability is typically tied to the business cycle.05 Length of average recession 2001 recession 1990-91 recession 1. The 1988 Basel Capital Accord required banks to maintain an 8 percent capital ratio. general macroeconomic conditions in the 2001 recession worked to the advantage of banks.46 percent.CURRENT ISSUES IN ECONOMICS AND FINANCE VOLUME 10. and vice versa. banks have used credit derivatives effectively to prune credit risk. Moreover. and nonperforming loan ratios fell from 3.We argue that this improved performance stems in large part from better risk management on the part of banks. suggesting that the efforts of banks (and regulators) to achieve this goal are paying off. we examine the slope of the yield curve: the difference between yields on tenyear and three-month Treasury maturities. as measured by return on equity. These rate declines made it easier for banks to increase their interest rate margins. The evidence that strategic management efforts have improved bank performance is less persuasive. meanwhile. author’s calculations. Department of Commerce. (The curve was actually inverted in the pre-recession quarter.00 Average of past recessions 0. The gains from revenue diversification. when firms do well. Although larger banks are becoming more diversified geographically. from 7. In addition.52 percent to 1. the interest rate environment was more favorable for banks at the beginning of the 2001 downturn than it was at the start of the prior recession.74 percent to 14. In terms of real GDP levels. interest rate changes aided banks. it has come at the cost of increased return-onequity volatility and decreased risk-adjusted returns.19 To put the 2001 recession in perspective. We find that the change in the slope was 1. bank assets tend to have longer maturities than bank liabilities. Comparing 1991 with 2002.53 percent. a 37 percent increase from the change of 1. to be sure. Because these institutions lend to firms across all industries.33 percent in terms of return on assets and nearly doubled. We find that risk management tools are being integrated more effectively in bank decision making. suggesting that the potential benefits of interstate diversification are declining.) Overall. Therefore. Therefore. passage of the Federal Deposit Insurance Corporation Improvement Act in 1992 placed banks under closer supervisory scrutiny.70 percent to 1. this has not translated into higher profitability.40 percentage points in the first quarter of the 2001 recession. the 2001 recession was milder than both the 1990-91 downturn and the average postwar recession Chart 4 (Chart 4). Bank efforts to manage risk were also complemented by the rapidly declining short-term interest rates associated with the 2001 recession. 6 . and significantly lower nonperforming loan ratios than they had shown at the start of the 1990-91 recession. we note that bank profits rose from 0. For example. banks can hedge this interest rate risk through the use of interest rate derivatives. A Comparison of Recessions by Real GDP Levels Index: 1 = NBER peak quarters 1. Although banks have steadily earned a larger share of their income from noninterest sources. Notes 1. banks have improved their ability to price the risk they assume.S. In addition. On average. state-level business cycles are becoming more alike.95 -4 -3 -2 -1 0 1 Peak quarter 2 3 4 5 6 7 8 9 Sources: U. NUMBER 1 The Case for Luck Two developments suggest that banks also benefited from a favorable operating environment as they entered the 2001 recession. as evidenced by the shrinking relative spreads of loans to corporate bonds in the syndicated loan market and the steeper pricing schedules in retail and small-business lending. the recession of 2001 was relatively mild when compared with the 1990-91 downturn and the average postwar recession.20 developments overall pointed to beneficial macroeconomic conditions for banks.02 percentage points in the first quarter of the 1990-91 recession. Second. so do banks. Regulatory activity no doubt played a role in some of these developments. which.

See Jorion (2001. British Bankers’ Association. Kevin. 18. 2003. n e w y o r k f e d . New York: McGraw-Hill.org/research/current_issues>. “Do Community Banks Benefit from Diversification?” Journal of Financial Services Research. federalreserve. Wendy. Dorothy Meadow Sobol is the editor. Scott Frame. 16. March 10.org/publ/joint04.2. Mass. 5. Donald.” NBER Working Paper no.bis. BBA Credit Derivatives Report 2001/2002. 4. 17. Donald. no. For example. mortgage guaranty underwriting). 2003-62. and Adrienne Rumble. “Bank Integration and State Business Cycles. Jorion. real investment in equipment and software fared worse than it did during the average recession.pdf>. Forthcoming b. Also see Berger. and Banking. and Katherine Samolyk. such as AA. 11. and Nathan H.” Unpublished paper.” Board of Governors of the Federal Reserve System. see also Gary Silverman and Charles Pretzlik. See Joint Forum (2001) for more on the increased adaptation and use of risk management techniques by financial services firms. 2003. Price. 20. 10. Credit. Stiroh. We use state-level personal income growth rather than gross state product because of the former’s higher reporting frequency: quarterly. Several studies on this topic are collected in Durkin and Staten (2002). 2003. Markets are defined as metropolitan statistical areas and rural areas.S. 8. On the impact of revenue diversification. Current Issues in Economics and Finance is published by the Research and Market Analysis Group of the Federal Reserve Bank of New York. Matthias. 2003. 13. “Risk-Based Pricing of Interest Rates in Household Loan Markets. “The Economic Effects of Technological Progress: Evidence from the Banking Industry. 15. Finance and Economics Discussion Series.” Unpublished paper. w w w. January 6.” Journal of Money. Forthcoming. and Philip E.: Kluwer Academic Publishers. Fitch Ratings.” November. 2002. p. Federal Reserve Bank of New York. 12. and Banking. no..newyorkfed. an observation that helps explain some of the difference. 2002. Miller. 6. Mono-line insurers write only one line of business. 2002-26. W. The full remarks. 2002. About the Author Til Schuermann is a senior economist in the Banking Studies Function of the Research and Market Analysis Group. Finance and Economics Discussion Series. Credit. Bankers Trust developed its RAROC (risk-adjusted return on capital) system in the 1970s specifically to address this issue (Jorion 2001). o r g / r e s e a r c h / c u r r e n t _ i s s u e s 7 . Allen N. and Michael Staten. October 21. “Global Credit Derivatives: Risk Management or Risk?” Fitch Ratings Credit Policy Special Report. Bertrand Rime. 9. May. Wary Lenders Scale Back Their Global Ambitions. 2002. Recoveries on defaulted bank loans tend to be somewhat higher than on corporate bonds. “The Joint Forum Risk Management Practices and Regulatory Capital Cross-Sectoral Comparison. Forthcoming a. such as workers’ compensation or credit insurance (for instance. Bank Holding Companies. “Geographic Diversification in Banking and Its Implications for Bank Portfolio Choice and Performance. 2004. chapter 1) for a brief history of risk management.” Financial Times. Thomas. another product that has been quite profitable for banks. Federal Reserve Bank of New York. Available at <http://www. ———. 11. Stiroh. p. Rieker. as opposed to annual. 3. There may also have been what economists call an endogenous effect: the 2001 recession may have been milder because better capitalized banks are more able to extend credit to firms facing weaker demand for products or services. Joint Forum. Morgan. 14. Moreover. The derivatives’ overall effectiveness is hard to measure precisely. We choose B. eds. 2nd ed. Philippe. mostly large banks participate in this market. are available at <http://www. But Trend May Not Last. Strahan. Morgan. most notably mortgage lending. Back issues of Current Issues in Economics and Finance are available at <http://www.htm>. Frame. 2003. Berger. “Diversification in Banking: Is Noninterest Income the Answer?” Journal of Money. Kevin. Value at Risk: The Benchmark for Managing Financial Risk. Certainly. “Credit Scoring and the Availability. 19. Durkin. Stiroh (forthcoming b) reports similar results for community banks. and Risk of Small Business Credit. Stiroh and Rumble (2003) find that the correlation between interest and noninterest income actually increased during the 1990s. 9704. “The Dark Side of Diversification for U. and Miller (2002). 9. 2001. References Berger. “The Myth of the Mega-Bank: After the Failures of Diversification. 7. “Retail Revitalized 3Q. Allen N. Edelberg. The Impact of Public Policy on Consumer Credit. 21. The views expressed in this article are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Norwell. 2003. Retail lending includes several other categories.gov/boarddocs/speeches/2003/20030508/default. so any credit risk transfer by means of credit derivatives is likely limited to this segment. Our results are even more pronounced when we remove transfer payments.” American Banker.and A-rated debt because we have significantly more observations in these grades than in higher grades.” Board of Governors of the Federal Reserve System. 2001. delivered May 8.

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